There are a lot of technical terminologies around loans and mortgages; it could be a home loan, project finance, gold loan, or even a car loan. One such relevant term is the Loan to Value ratio (LTV Ratio.
To get a fair idea on this, let us dive deeper into what a Loan-To-Value Ratio is, how it works, and the kind of difference it creates for both the parties to the transaction, i.e. the lenders and the borrowers.
Loan-To-Value Ratio (LTV Ratio) or Loan-To-Cost Ratio (LTC Ratio) is as simple as it sounds. It determines nothing but the maximum amount based on the market value and liquidity of the asset pledged as collateral in case of a secured loan. In simpler terms, borrowers allow the lenders a claim to the asset, in case they are not in a position to repay the loan at any given point in time. LTV simply tells the loan applicant the maximum percentage of the value of the pledged asset that he can borrow.
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The final amount of borrowing is determined on multiple factors including but not limited to the value of the security, eligibility of the borrower, a good CIBIL Score, etc. To determine the maximum amount that can be lent, the financial institution shall use this LTV ratio to cap the maximum amount of loan depending on the value of the security. Let us understand the calculation of the LTV ratio.
LTV = (Loan amount/Appraised value of the asset) x 100
Suppose, a borrower is seeking a loan against the property of INR 50 Lakhs urgently and the lender after ticking off the basic loan against property eligibility criteria as above checks out the amount to be sanctioned to be INR 40 Lakhs then the LTV ratio would be as follows –
LTV = (40 Lakhs/50 Lakhs) x 100 = 80%
The above example states that the lender would sanction INR 40 Lakhs. Lenders determine the LTV after appraising the value of the asset pledged. For instance, if the pledged asset is a house, which is brand new, and has been built in a prime location, then the loan amount given loan against the property is higher (75% - 80%). On the other hand, older properties which may become more cumbersome to sell or whose value may not increase attract lower loan amounts.
The LTV ratio is an important metric that assesses the lending risk a lender bears by providing a loan as per the borrower’s requirement. The rate compares the size of the loan requested against the size of the collateral pledged while evaluating the borrower’s loan proposal. In case of foreclosure or default by the borrower, higher LTV limits the chances of proceeds of sales to cover the outstanding principal and accrued interest. As against this, a lower LTV is a saver if the lender has to foreclose on the loan.
Therefore, analyzing both sides by the study of the LTV ratio is of utmost importance.